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1. Question1
Work through the Web Exercise at the end of the chapter.
Comment on your most interesting findings on Johnson and
Johnson (JNJ).
StrIS'tgOUd
6dcuetctge eqtr sI 1eqid 'c
'lq8le leuotltsod lseleer8 3o repro u1 'q
't {8le leuotltsod }seleerB :Je{eeJqeIJ 'qse1 Eurrrrollo; lsoluJo
Jepro uI 'e
:se1ru Bur,r,ro11o; eql Eursn suorlels{ro o1 (selnurur ur ere
serutl) ruer8erp ecuepecerd 3ur,{ued
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doqs eqt eumssY'slpm 7gglo ln4"o lf )
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'c
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s{s?l IIe roJ
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'€
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226 Part 2 Analysis and Valuation of Equity Securities
extraordinary gains and
losses 223
forward price-earnings
ratio 213
income statemerrt 2OO
inflation-adjusted
accounting 221,
liquidity ratios 2L-1.
price ratios ztz
profitabilityratios 2O8
statement of cash
flows 2O3
trailing price-earnings
ratio 273
trend analysis 217

6. al
j
/
L
ffi PRAcrtcE pRoBLEMS AND solurtoNs
1. Given the following financial data: Net income/Sales : 4
percent; Sales/Total
assets : 2.8 times; Debt/Total assets : 40 percent; compute:
ct. Return on assets.
b. Return on equity.
c. If the Debt/Total assets ratio were 70 percent, what would
Return on
equity be?
ffi KEY woRDs AND coNcEPTs
asset-utilization
ratios 21O
balance sheet 2Ol
debt-utilization
ratios 21'1,
dividend-payout
ratio 21.4
dividendyield 214

7. ffi DlscusstoN ouEsrroNs
@oo", abalance sheet that is dated year-end 2007 reflect only
transacrions for
that year?
/an
(])Explain why the statement of cash flows is particularly
relevanr in light of the
fact that the accruai method of accounting is used in the income
statement and
balance sheet.
() aur-, we automatically assume that afirm that has an
operating loss on the
income statement has reduced the cash flows for the firm during
the
period?
X4tat ratios are likely to be of greatest interest to the banker or
trade creditor?
To the bondholder?
p ff a firm's operating margin and after-tax margin are almost
the same (an
unusual case), what can we say about the firm?
6. comment on the heary capital goods industry and the food-
processing indus-
try in terms of performance under the DuPont system of
analysis.
7. In computing return on assets, how does the age of the assets
influence the
interpretation of the values?

8. 8. If a firm's return on equity is substantially higher than the
firm's return on
assets, what can the analyst infer about the firm?
9. How do the asset-utilization ratios relate to the liquidity
ratios?
LO. Can public utility firms better justify the use of high debt
than firms in the auto-
mobile or airline industry? Comment.
LL. Vhy will the fixed-charge-coverage ratio always be equal to
or /ess than times
interest earned?
12. what might a high dividend-payout rario suggesr ro an
analyst about a compa-
ny's growth prospects?
lJ. Explain the probable impact of replacement-cost accounting
on the ratios of
return on assets, debt to total assets, and times interest earned
for a firm that
has substantial old fixed assets.
DuPont analysis
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208
DISCUSSION
AND REVIEW
QUESTIONS
TAKING STOCK Q wr,.tarethemajortrade-
offsincapacityplanning?
Q) Wt o needs to be involved in capacity planning?
@ln what ways does technology have an impact on capacity
planning?
CRITICAL
THINKING
EXERCISES
1. A computer repair service has a design capacity of80 repairs
per day. Its effective capacity, how-
eveq is 64 repairs per day, and its actual output is 62 repairs per
day. The manager would like to
increase the number of repairs per day. Which of the following
factors would you recommend that
the manager investigate: quality problems, absenteeism, or
scheduling and balancing? Explain your

13. reasoning.
2. Compared to manufacturing, service requirements tend to be
more time dependent, location depen-
dent, and volatile. In addition, service quality is often directly
observable by customers. Find a
recent article in a business magazine that describes how a
service organization is struggling with
one or more of these issues and make recommendations on what
an organization needs to do to
overcome these difficulties.
3. Identifi, four potential unethical actions or inactions related
to capacity planning, and the ethical
principle each violates (see Chapter 1).
1. Determine the utilization and the efficiency for each of these
situations:
a. A loan processing operation that processes an average of 7
loans per day. The operation has a
design capacity of 10 loans per day and an effective capacity of
8 loans per day.
b. A furnace repair team that services an average of four
furnaces a day if the design capacity is six
furnaces a day and the effective capacity is five furnaces a day.
c. Would you say that systems that have higher efficiency ratios
than other systems will always
have higher utilization ratios than those other systems? Explain.
PROBLEMS
Ghapter Five Strategic Capacity Planning for Products and
Services

14. 1. Contrast design capacity and effective capacity.
2. List and briefly explain three factors that may inhibit
capacity utilization.
3. How do long-term and short-term capacity considerations
differ?
4. Give an example of a good and a service that exhibit these
seasonal demand patterns:
a. Annual
b. Monthly
c. Weekly
d. Daily
5. Give some examples of building flexibility into system
design.
6. Why is it important to adopt a big-picture approach to
capacity planning?
7. What is meant by "capacity in chunks," and why is that a
factor in capacity planning?
8. What kinds of capacity problems do many elementary and
secondary schools periodically experi-
ence? What are some alternatives to deal with those problems?
9. How can a systems approach to capacity planning be useful?
1 0. How do capacity decisions influence productivity?
11. Why is it important to match process capabilities with
product requirements?

15. 12. Briefly discuss how uncertainty affects capacity decisions.
13. Discuss the importance of capacity planning in deciding on
the number of police officers or fire
trucks to have on duty at a given time.
14. Why is capacity planning one of the most critical decisions
a manager has to make?
15. Why is capacity planning for services more challenging than
it is for goods production?
16. What are some capacity measures for each of the following?
a. University
b. Hospital
c. Computer repair shop
d. Farm
17. What is the benefit to a business organization of having
capacity measures?
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190 Part 2 Analysis and Valuation of Equity Securities
ffi suMMARy
This-chapter presents severar common stock valuation
dends and earnings per share. For the valuation to be
earnings and dividends needs to be correct.
free cash flow 1g5
growth companies 775
growth stock 775
hidden assets 189
least squares trend
analysis 185
price-earnings ratio 177
models that rely on divi-
accurate, the forecast of
required rate of
return 165
retention ratio 174
risk-free rate 165
sustainable growth
model 173
valuation 164
Firms can be varued_in many ways, and, afianalyst may use
severar methods tosubstantiate estimates. varuation mojels

19. based pri^"rrty on airia"rrds rook atfuture prol'ections of
diviclends and the associated present values of the
dividends.Assumptions must be made as to whether the divii""a
gro-tn paftern is constant,accelerating. or decreasing.
. calculating the p.op"i rare of return for the valuation of a
company,s stock isimportant. The capital Asset pricing Model is
used
^ u--"thoa'"r.rr."irtr"sreturn. 7e also discuss the problemi with
heta and the ;di;y risk premium. Analternate return methocl is
presented where the company,s corporate bond yield isused as a
baseline for the iequired rate of return.
The analysis of a firm's growth rate is a very important part of
the valuationprocess' sre discuss the various ways of
analyzingg.o*.tn i".riamg the sustainablegrowth model and
the.rerationship berween thJ lriving fo.c.s of growth.
Thesedriving forces of growth are a function of sales g.o*f,; ire
,,u.io* reration_ships between profit margins, payout ratios, and
number of shares outstanding.valuation using the earnings
method requires that a price-earnings ratio be usedas a
multiplier of Eps. price-earnings ratios are influenc"a ny lrlrrry
variables such asgrowth, risk, capital stnrcture, dividend poriry,
revel of the market in general, in<lustryfactors, and more. A
careful study of eaih situation must be concludecl before choos-
ing the appropriate P/E. The price-earnings ratio is a function of
two fluctuating vari-ables-earnings and price. The two
variab"les combine to form a ratiothat is primarilyfuture
oriented' High price-earnings ratios usually indicate positive
expectations of thefuture, whereas low price-earning-s ratios
connote negative expectations.
To choose ap/Ethat is reasonable, the analyst must have some
idea about theexpected grou.th rate in earnings per share.-
Investors may find earnings estimates ininvestmenr advisory
se.ices, in itatisticar forecasrs t;;;.rge houses, throughtheir own
time series statisticar regression anarysis,

20. ", "1y "r;;;h'" income statementmethod' Growth stocks were
clisc-ussed more with the view oialerting the student towhat to
look for when trying ro identig/ a growth stock or ;o_prrry than
with theconcept of valuation' The previously developed methods
of valuailon can be used ongrowth stocks as long as care is
taken to evaluate the durationu.ra t"r."t of growth.we also
presenred some basic ideas about rhe varue ;i;;;;r".s basecl nor
ontheir earmngs or dividend stream but on their assets such as
cash or natural resources.
ffi KEY woRDs AND coNcEprs
beta 165
dividend valuation
models '1,65
earnings valuation
model 165
EBITDA 185
equity risk premium
(ERP) 55
ffi DrscusstoN ouEsrtoNs
L' To determine the required rate of return, K", what factor is
aclcled to the risk_free rate? (Use FormulaT_2 on page f66.)
[Q Whar does beta represenr?
I What does the equiry risk premium (ERp) represent?
4- How is value interpreted under the dividend valuation model?